Apple Hospitality REIT, Inc. — 2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014; quarterly figures below include the fourth quarter. The filing was signed March 6, 2015. The company is a self-advised U.S. lodging REIT operating one segment.
Business context and reporting period
At year-end, Apple Hospitality owned 191 hotels with 23,790 rooms across 33 states, all operating under Marriott- or Hilton-family brands. The March 1, 2014 mergers with Apple REIT Seven and Apple REIT Eight added 99 continuing hotels. Accordingly, 2014 results include ten months of those properties, making reported year-over-year comparisons substantially affected by the mergers.
Financial and operating metrics
| Metric | 2014 | 2013 |
|---|---|---|
| Total revenue | $803.9 million | $388.0 million |
| Operating income | $32.3 million | $82.7 million |
| Net income | $6.8 million | $115.2 million |
| Diluted earnings per share | $0.02 | $0.63 |
| Cash from operating activities | $252.2 million | $137.4 million |
| Capital improvements and development cash outflow | $68.0 million | $22.5 million |
| Distributions paid | $233.4 million | $151.6 million |
Reported revenue rose largely because the mergers expanded the portfolio. For 89 hotels owned throughout both years, ADR increased 5% to $121, occupancy increased to 76% from 74%, and RevPAR rose 7% to $91. Pro forma statistics for the year-end portfolio also showed RevPAR growth of 7%, to $92 from $86.
Fourth quarter: Revenue was $202.3 million versus $90.8 million in Q4 2013. Income from continuing operations was $22.3 million versus $23.3 million; net income was also $22.3 million versus $56.6 million, with the prior-year quarter including $33.3 million of discontinued-operations income. Q4 diluted EPS was $0.06 versus $0.31.
Hotel operating expenses were 57% of revenue in both 2014 and 2013; property taxes, insurance and other expenses were 5% in both years. The annual net-income decline reflects, in particular, a $117.1 million noncash expense from conversion of Series B preferred shares, an $11.0 million property impairment, higher depreciation and interest, and merger-related costs. The company reported FFO of $131.2 million and modified FFO of $256.4 million; the latter includes substantial add-backs, including the preferred-share conversion expense, and is a non-GAAP measure.
Debt, liquidity and capital allocation
At December 31, 2014, cash was zero. Total debt carrying value was $709.6 million: $192 million under the unsecured credit facility and $518.0 million of mortgage debt. The credit facility consists of a $245 million revolver and a $100 million term loan; $191.6 million was outstanding, including the term loan. The revolver’s stated annual rate was approximately 1.77%; the term loan was effectively fixed at approximately 3.13% through a swap. The company reported compliance with facility covenants.
Operating cash flow exceeded 2014 distributions paid, but distributions exceeded GAAP net income. The annualized distribution rate was reduced from $0.83025 to $0.66 per share effective March 2014, then increased to $0.68 effective September 2014. The board retains discretion to change or suspend distributions; the credit agreement generally limits distributions and share repurchases to 100% of FFO, subject to REIT requirements.
2014 capital improvements on existing hotels were approximately $48.3 million. Management anticipated an additional $50–$60 million of capital spending in 2015. The company held $27.5 million in capital reserves at year-end. Contractual obligations included $819.5 million of debt payments, including stated interest, and $320.9 million of ground lease payments.
Material changes, outlook, risks and unusual items
- Portfolio transaction: In February 2015, the company sold 18 of 19 hotels classified as held for sale for $206.4 million; the remaining hotel, with a $6.6 million contract price, was excluded by the buyer. The company expected to record a gain in Q1 2015 and planned to use proceeds for revolver repayment, acquisitions and renovations.
- Outlook: Management and the industry forecast a mid- to upper-single-digit percentage revenue increase for 2015 on a comparable basis. This is an outlook, not formal earnings guidance. Management cited continued demand and rate improvement, while noting market-specific pressure from reduced government spending and new hotel supply.
- Merger and other unusual items: The mergers issued approximately 180 million common shares and resulted in a $117.1 million noncash preferred-share conversion expense. Merger-related costs totaled approximately $6.4 million over 2013–2014. Three properties generated an $11.0 million impairment charge in 2014 following a change in expected holding period. The company also acquired an 88-room hotel through foreclosure and opened two Richmond hotels in December.
- Operating and financial risks: Hotel results are exposed to economic conditions, travel demand, competition and seasonality; labor, utility, property-tax and renovation costs; reliance on third-party managers; concentration in Marriott and Hilton brands; interest rates, refinancing and debt covenants; ground leases; natural disasters and insurance limitations; and REIT qualification and distribution requirements.
- Legal and governance matters: Several shareholder disputes connected with the mergers and dividend reinvestment plans remained pending or subject to further proceedings. The company said it could not reasonably estimate possible loss. Related-party relationships and cost-sharing arrangements remain significant; the company disclosed potential conflicts involving its Executive Chairman and affiliated entities. A prior SEC settlement required cease-and-desist undertakings and civil penalties for specified parties and had no impact on the company’s financial statements.
- Shareholder liquidity and valuation: There was no established public trading market. The company’s estimated December 31, 2014 share value was $10.30, based on a third-party valuation range of $9.80–$10.80; it is not a market price or guaranteed realizable value. A limited redemption program was reinstated, with eligibility narrowed to death of a shareholder in February 2015.
- Controls and audit: Management and Ernst & Young concluded internal control over financial reporting was effective, and the auditor issued an unqualified opinion on the financial statements.
Most important facts for investors to verify
- Assess merger-adjusted operating trends using comparable or pro forma RevPAR, rather than relying on reported revenue growth alone.
- Reconcile the $117.1 million noncash preferred-share charge and other adjustments when evaluating GAAP earnings against FFO, modified FFO and adjusted EBITDA.
- Review the 2015 hotel-sale proceeds, recognized gain, use of funds and resulting debt and liquidity position.
- Check debt maturities, floating-rate exposure, covenant headroom and planned capital spending against cash flow and distribution commitments.
- Monitor the pending shareholder litigation, related-party arrangements, REIT compliance, and the practical limits on share liquidity and the estimated share value.